Business Today

Keeping Companies Above Board

How board members can ensure good corporate governance.
Kanishka Gupta   New Delhi     Print Edition: November 5, 2017
Keeping Companies Above Board
Illustration by Ajay Thakuri

The recent report of the Securities and Exchange Board of India (SEBI) -appointed Uday Kotak Committee, alongside the two high-profile corporate battles of the past year - Ratan Tata versus Cyrus Mistry at Tata Sons in late 2016 and N.R. Narayana Murthy versus Vishal Sikka at Infosys in mid-2017 - have turned the spotlight squarely on corporate governance and, in particular, the performance of company boards. There is no doubt that there exists much more transparency and stakeholder democracy in companies now than before, thanks mainly to the new Companies Act of 2013 as well as earlier rules set by SEBI in recent years.

SEBI has not only made regulations but also acted to enforce them. A well known instance was the case of Chennai-headquartered IT company, Zylog Systems, which declared a dividend for its shareholders at its annual general meeting (AGM) on September 25, 2012, but failed to actually distribute it. Responding to complaints, SEBI, after due enquiry, barred the company from "buying, selling or dealing in securities in any manner whatsoever" and recommended action against the directors. But it also clarified the role of independent directors on boards by declaring, in a subsequent ruling, that the two independent directors should be spared, since they could not be "held responsible for the day-to-day functioning of the company" and had resigned within two months of the lapse coming to their notice.

Even unlisted companies have been improving their governance, primarily due to the increasing investments they have been receiving from overseas venture capital and private equity funds as well as institutional funds such as CalPERS, Canadian pension fund CDPQ, Harvard University Management Co, and more, which insist on high standards. Even so, the Kotak Committee recommendations show that much more can be done and higher standards aspired to. It has suggested splitting the roles of the Chairman and CEO of companies, appointing a minimum of six directors and a maximum of eight in listed companies, at least half of whom should be independent, bringing much more transparency to the appointment of independent directors, and much more.

Many rules setting high standards are no doubt in place, but as the Tata Sons and Infosys instances showed, a case can be made for greater regulatory enforcement. Interventions promoting good corporate governance are still too few and mismanagement at the highest level only occasionally becomes public knowledge. "Some of our members' experiences on the boards of certain companies exposed vulnerabilities in the enforcing of regulations," says Mathew John, Head of Partnerships and Communications, Association of Independent Directors of India (AIDI). He cited the example of a company writing off a debt without the knowledge or consent of board members. Other company directors mentioned instances where minutes of board meetings and even audit meetings were not accurately recorded, or were made available after long delays. Still others spoke of auditors being appointed bypassing due processes, AGMs being held without proper board approval, or collective winking at the promoter's misappropriation of funds, as regular occurrences.

Arvind Mathur, Chairman, Private Equity Pro Partners (Photo: Vivan Mehra)

Ensuring Best Practices

What can be done to ensure companies adhere to best practices? Obviously, these will vary from company to company, depending on its size and sector. But it is the duty of board members to point them out, as it is one of the CEO's most important tasks to choose the best practices applicable to his company. Among the most important is imbuing the company with the right kind of culture - open, forward looking, with strong adherence to ethical practices, as the Kotak Committee also emphasises.

For a start, board members can set an example by ensuring conflict of interest issues do not arise. "Conflict of interest should not be allowed to arise at all," says Shailesh Haribhakti, Chairman of chartered accountants firm Haribhakti & Co. "I'm on the board of seven companies, but to prevent conflict, I strictly avoid companies with common shareholding, partnerships or board engagements. Beyond that, choice of companies should be strictly on merit. Ultimately the test is: can you sleep well after your head touches the pillow at bedtime?"

Boards can give direction not only in ensuring transparency, but also in other areas such as risk prevention and strategy. "The core of corporate governance is the fiduciary responsibility of the top management and the board in holding the enterprise in trust for the future, for long-term sustainable profitability rather than short-term profit at any cost," says Mathew of AIDI. While in most Indian companies, risk management is generally treated as a routine compliance item, the boards of two leading cement companies, ACC and Ambuja Cements, for instance, have taken a healthy new approach by initiating the formation of a specialist risk management committee whose sharp focus on assessing, managing and mitigating risks led to several insights which proved strategically valuable for them.

Risks can emanate from various sources - aggressive competition, cyber attacks or even environmental protection activism. In the wake of the worldwide ransomware attacks, WannaCry and Petya in June this year, for example, a number of company boards have steered their managements towards taking preventive action. "On five of the boards where I serve, a simple sharing of information on the potential damage ransomware and malware can inflict has led to establishing a response mechanism and a culture of intolerance towards any laxity in cyber security," says Haribhakti. At the same time, boards should define their limits - operational risks, for example, which the management is perfectly capable of handling, should not be included in the board's risk framework.

As for boards helping to sharpen strategy, an instance is the increased emphasis L&T Finance Holding's board decided to place on return on investment (RoI). Board conversations focused solely on achieving the best RoI in the industry. The company cut down on the number of products it was offering, retaining only those which were doing exceptionally well. Non-performing assets were ruthlessly reduced by provisioning, restructuring and selling down - and the results were soon visible in quartile RoI jumps.

Sharad Abhayankar, Partner, Khaitan & Co (Photo: Rachit Goswami)

The board's job is to take a bird's eye view of not just the company but the entire sector and the economy as a whole, helping managements to step back if necessary and get a clearer picture of possible dislocations in the market. As recommended by the Kotak Committee, board members need to be more proactive than at present, and possessed of a wide range of knowledge and abilities. "If a board member spots a great opportunity, he must bring it to the board's attention," says Haribhakti. "If directors don't do so, they are not giving their best."

Diversity in selection of members is also vital. "We have evidence that diversity among directors, as well as the extent of directors' involvement in a company, affects company performance," says Mathew. The more actively board members participate in board meetings, the better for the company, industry watchers feel. Again, the inclusion of women members on boards - the new Companies Act and later directives by SEBI have made it mandatory to have at least one - has helped bring balance to them and signals their commitment to good governance and ethical practices. The Kotak Committee has gone a step further and recommended at least one independent woman director in listed companies.

As a corollary, poor board functioning affects company functioning. The worst is when board members make rambling, inconsequential interventions at meetings without having done any homework. The board chairman can correct this by framing each meeting's agenda carefully, holding private conversations with erring board members exhorting them to change their approach and by strictly guiding the course of the conversation - ensuring that the knowledgeable, however shy or retiring personalities they may be, are given their chance to speak, while cutting short the loudmouths. If the chairman is not assertive, the board risks drifting into pure compliance mode - ensuring only that the minimum formalities required by company law are completed. This is a dangerous trend and can affect the company's functioning. "Board meetings should aim to focus on strategy for 50 per cent of the time, on execution for another 30 per cent and only the remaining 20 per cent should be devoted to compliance issues," says Haribhakti.

Finally, as the Tata Sons and Infosys controversies underline, Indian boards have yet to clearly delineate the roles of promoter families - who may or may not have majority shareholding - and company founders. To what extent can they control the board and its chairman, and how should their views be responded to, especially in a crisis? More research and a study of best practices elsewhere are needed to answer these questions.

Audit Committee Challenges

A subset of the board is the audit committee, usually comprising three board directors, at least two of whom should be independent. Serving on one is extremely challenging, given the need to oversee the company's accounting and financial reporting systems, the internal auditor and the independent auditor, deal with constant pressure from regulatory bodies, investors and shareholders, and keep track of ever-changing agendas and ever-increasing risks. Being financially literate is just the baseline requirement - members need to be well versed in sophisticated financial transactions, reporting processes and more, with significant experience behind them, preferably in the very sectors in which the company operates. The Kotak Committee has further recommended they should meet at least five times a year.

Mathew John, Head, Partnerships and Communications Association of Independent Directors of India (Photo: Vivan Mehra)

Experts feel audit committees should be ready and willing to co-opt experienced outsiders from time to time to help them discharge their mandate. Lately, a number of them have been turning to company advisory boards - comprising individuals with a wide spectrum of expertise and experience - for help in understanding the nuances of new global markets companies would like to expand into. As geographical boundaries in trade melt away and financial reporting standards converge, it is important for audit committees to get to know local markets, local management styles and local risk factors closely.

The buzzword among audit committees today is "integrated reporting" - or disclosures that not only cover a company's financial capital but also other factors that create value for it, such as its natural capital, social and relationship capital, intellectual capital, human capital and manufactured capital. SEBI has urged enterprises to voluntarily adopt integrated reporting sooner rather than later, which means audit committees will also need to acquire a profound understanding of all of these and the ways they create value for stakeholders. "Embracing integrated reporting will promote a more cohesive approach to reporting the range of factors that affect the ability to create value over time," says Sharad Abhyankar, Partner, in advocate firm Khaitan & Co.

Wages of Transparency

Greater transparency is an admirable objective, but revealing too much of strategy and seeking shareholders' assent at every step could also lead to potentially value enhancing proposals being shot down if a sufficient number of minority shareholders or institutional investors do not see merit in them. Genuine perception differences between shareholders and the key management personnel may well arise. But transparency has also enabled the growth structured and nuanced shareholder activism, supported by proxy advisory firms, and this trend could gain further traction.

In coming years, there will be increased scrutiny of board composition with boards expected to provide more details of their directors' profiles, their qualifications and competencies and the roles they are expected to play. "Board appointments can at times be a mutual back- scratching exercise by people who have reasons to promote each other," says Arvind Mathur, Chairman, Private Equity Pro Partners. "Indian corporate players need more training from specialists."

Given the pace of change, especially the onset of new technologies, the ability to adapt quickly will be vital to the efficient functioning of company boards. Technological change can lead to abrupt shifts in competition and strategy. "I think boards will have to become much more involved in company strategy and management than in the past, because of these new challenges," says Mathew. Boards will need to take ownership of companies, challenge managements and ask it the right questions.

Despite the increased transparency, India still lags behind countries such as Australia and Singapore in the level and quality of its corporate disclosures. Experts feel India would do well to benchmark its best practices against those in these two countries. Nor is there any objective yardstick to assess the functioning of boards or the quality of corporate governance. Haribhakti believes that improvement is only possible by seeking feedback after every board meeting. "The idea I'm pushing for is to make every meeting better than the previous one and to identify specific improvement opportunities," he says.

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